Whether you can be held personally liable for the debts of your business depends on the structure of your business and how it was formed. Read on to learn more about when you are personally liable for business debts and when you are not.
You are likely a sole proprietor if you are the only owner of your business and you have not incorporated or set up a specific form of business entity for it. A sole proprietorship is not a separate legal entity. You and your business are considered the same and are equally liable for debts incurred by the business.
Since a sole proprietorship does not offer limited liability to its owner, creditors of the business can go after your personal assets in addition to business assets. This means that if the business does not have sufficient assets, creditors may sue you and try to collect the debt by taking your house, car, or other personal property.
A partnership is an unincorporated business entity owned by two or more individuals. There are several types of partnerships.
A general partnership can be automatically created without any paperwork if two or more people agree to carry on a business or activity for profit. Each partner is considered a general partner and is personally liable for the debts of the partnership. If your business is a general partnership, you will be responsible for the obligations of the business.
In a limited partnership there is at least one general partner and at least one limited partner. The general partner is personally liable for partnership debts while the limited partner is not. This means creditors can collect from the personal assets of the general partner but not the limited partner.
Limited Liability Partnership (LLP)
An LLP is designed to shield all partners from personal liability for the debts of the business. In some states all partners enjoy limited liability but there are states that require an LLP to have at least one general partner. Also, in certain states the liability protection of the LLP only applies to negligence claims so all partners may still be liable for business debts arising out of a contract (such as business loans or credit cards).
A corporation is an incorporated entity designed to limit the liability of its owners (called shareholders). Generally, shareholders are not personally liable for the debts of the corporation. Creditors can only collect on their debts by going after the assets of the corporation.
Shareholders will usually only be on the hook if they cosigned or personally guaranteed the corporation’s debts. However, shareholders may also be held liable if a creditor can prove corporate formalities were not followed, shareholders commingled personal and business funds, or the corporation was just a shell designed to shield liability. This is called piercing the corporate veil. (To learn more, see Piercing the Corporate Veil: When LLCs and Corporations May Be at Risk.)
Limited Liability Company (LLC)
Similar to a corporation, an LLC offers limited liability to its owners (called members). Generally, members are not liable for the debts of the LLC unless they cosigned or guaranteed the debt personally. However, like a corporation, creditors may also be able to go after the members’ personal assets by piercing the corporate veil.
(To learn more about different business structures, how to form them, and the rules that apply to them, see our Business, LLCs & Corporations Center.)